China: 4 Sore Spots To Keep An Eye On

I mentioned in my blog last week that China’s resilience during the 2008 financial crisis made it the envy of many nations. However, it seems like big ol’ China has a few sore spots in its economy too! Here are four of them:

High inflation

If you don’t know that inflation is a big pain in China’s butt, you must be living under a rock! Just last week, we saw that inflation rose at its fastest pace in almost three years as May’s CPI report came in at 5.5%.

Remember that inflation (i.e., the rise in cost for goods and services) undercuts the purchasing power of consumers. This is why China’s central bank (a.k.a. the People’s Bank of China (PBOC)) hiked the reserve requirement ratio (RRR) for the third time this year by another 50 basis points this past Tuesday.

This means that banks in the country have to leave 21.5% of their deposits sitting in their vaults. By locking up funds, less money is available in the economy for circulation (loans or investment) which may help tame inflation.

Slowing growth

Too bad China’s move towards a tighter monetary policy isn’t all sugar, spice, and everything nice. Naysayers think that economic growth would suffer as a consequence of the PBOC’s hike. Why? Just think about the opportunity cost of all that money gathering dust which people could use for investment and spending!

In fact, a few economic gurus are saying that the disappointment posted by the most recent manufacturing reports already reflect the side effects of the central bank’s monetary policy tightening.

The government’s calculation shows that manufacturing activity slowed down for the third straight month in June with the index down at 50.9 from 52.0 in May. Meanwhile, the HSBC manufacturing PMI hit an 11-month low at 50.1 in June following its previous reading of 51.6.

Real estate bubble

The ripple effect of the PBOC’s move also extends to the China’s real estate market. Property prices in the country have risen to their highs thanks in part to low interest rates in the country. But as the central bank continues to tighten its monetary policy, acquiring loans will get more expensive. This means that demand for houses would probably drop as fewer people will be able to afford cribs in downtown Shanghai.

It also doesn’t help that the government has gone on a spending frenzy in building infrastructure that may result in an oversupply in residential and commercial real estate.

Having learned from Economics 101 that both low demand and high supply lead to lower prices, analysts estimate that house prices would drop by 10% within the next year.

Hotshots at S&P must have also done their research on China’s real estate market. In June, the credit rating agency downgraded its outlook for China’s real estate development sector from “stable” to “negative.”

Mounting debt

Yep! Like the U.S. and the Euro Zone, China has debt problems too! After doing a little spy work, I found out that local governments have accumulated 10.7 trillion CNY (1.65 trillion USD) in debt at the end of 2010. According to the National Audit Office, that’s equivalent to 26.9% of the country’s GDP for the year.

As if that’s not bad enough, Moody’s said that the government’s calculations might even be underestimated by about 3.5 trillion CNY! Yikes!

Where did all that money go?

Market junkies say that most of it was used to fund infrastructure projects. You see, local governments were allowed to issue bonds to pay for their spending following the 2008 financial crisis. Sure it helped keep the economy afloat when poop hit the fan, but it also allowed local governments to spend more than what they could afford.

If their debts go bad, banks that hold the most bonds would probably need to be bailed out by the national government. Uh oh…

When the financial crisis crippled most economies, the world turned to China’s resilient growth for support. But with these problems, is China’s time under the spotlight about to end soon?

It might be too early to tell. So tune in to the roster of economic reports we have on tap from China this week to better gauge which direction its economy is heading! If I were you, I’d stay on my toes for evidence of further weakness as this would probably send higher-yielding currencies lower.

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